Dana Kiku

Duke University, Durham, NC, United States

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Publications (15)17.32 Total impact

  • Hengjie Ai, Dana Kiku
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    ABSTRACT: This paper explores the relationship between volatility and growth options. We argue that while the value of a growth option increases with idiosyncratic volatility, its response to volatility of aggregate shocks is ambiguous. Building on these theoretical insights, we propose to measure option intensity by firms' exposure to idiosyncratic volatility. We show that our measure carries significant information about firms' future investment, even after controlling for conventional proxies of growth options such as book-to-market and other relevant firm characteristics. Consistent with our theoretical arguments, we also show that firm' exposure to aggregate volatility does not help predict their future growth. In addition, we show that option-intensive firms, identified using our volatility-based measure, earn a lower premium than do firms that rely more heavily on assets in place.
    SSRN Electronic Journal 08/2012;
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    Ravi Bansal, Dana Kiku, Amir Yaron
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    ABSTRACT: The long-run risks (LRR) asset pricing model emphasizes the role of low-frequency movements in expected growth and economic uncertainty, along with investor preferences for early resolution of uncertainty, as an important economic-channel that determines asset prices. In this paper, we estimate the LRR model. To accomplish this we develop a method that allows us to estimate models with recursive preferences, latent state variables, and time-aggregated data. Time-aggregation makes the decision interval of the agent an important parameter to estimate. We find that time-aggregation can significantly affect parameter estimates and statistical inference. Imposing the pricing restrictions and explicitly accounting for time-aggregation, we show that the estimated LRR model can account for the joint dynamics of aggregate consumption, asset cash flows and prices, including the equity premia, risk-free rate and volatility puzzles.
    08/2012;
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    ABSTRACT: We show that volatility movements have first-order implications for consumption dynamics and asset prices. Volatility news affects the stochastic discount factor and carries a separate risk premium. In the data, volatility risks are persistent and are strongly correlated with discount-rate news. This evidence has important implications for the return on aggregate wealth and the cross-sectional differences in risk premia. Estimation of our volatility risks based model yields an economically plausible positive correlation between the return to human capital and equity, while this correlation is implausibly negative when volatility risk is ignored. Our model setup implies a dynamics capital asset pricing model (DCAPM) which underscores the importance of volatility risk in addition to cash-flow and discount-rate risks. We show that our DCAPM accounts for the level and dispersion of risk premia across book-to-market and size sorted portfolios, and that equity portfolios carry positive volatility-risk premia.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
    The Journal of Finance 05/2012; · 4.22 Impact Factor
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    ABSTRACT: In this paper we develop an economic asset pricing framework that identifies three key sources of risk that underlie the risk and return trade-off in the economy: news to cashflows, news to expected returns, and news to aggregate volatility. A novel contribution of this paper is the inclusion of time-varying volatility news which has both important theoretical and empirical implications. Motivated by a Long Run Risk framework, we theoretically show that to consistently identify and explain the time series and cross sectional variation in risk premia it is essential to allow for time varying economic uncertainty in the model. Empirically, we show that the exposure of assets to volatility risk, sorted by size and book to market, line up vary well with those assets’ average excess return in the data. The model’s fit of a broad cross section of asset returns is about 90% of which the volatility news factor contributes 20%. The volatility component plays a significant role in explaining the level of the premium as well as the value and size spreads.
    03/2011;
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    ABSTRACT: We put forward a general equilibrium model to study the link between the cross section of expected returns and book-to-market characteristics. We model two primitive assets: value assets and growth assets that are options on assets in place. The cost of option exercise, which is endogenously determined in equilibrium, is highly procyclical and acts as a hedge against risks in assets in place. Consequently, growth options are less risky than value assets, and the model features a value premium. Our model incorporates long-run risks in aggregate consumption (as in Bansal and Yaron (2004)) and replicates the empirical failure of the conditional CAPM prediction. We show that the model is able to quantitatively account for the observed pattern in mean returns on book-to-market sorted portfolios, the magnitude of the CAPM-alphas, and other silent features of the cross-sectional data. Yaron. We also want to thank seminar participants at the Federal Reserve Bank of Minneapolis; the Finance department of the University of Minnesota; SED 2008; the Finance department at the Wharton School, University of Pennsylvania; WFA 2009 meetings; and the UBC Winter Finance Conference 2010 for their helpful comments. The usual disclaimer applies.
    07/2010;
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    Ravi Bansal, Dana Kiku, Amir Yaron
    American Economic Review 05/2010; 100(2):542-46. · 2.69 Impact Factor
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    Ravi Bansal, Dana Kiku, Amir Yaron
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    ABSTRACT: We provide an empirical evaluation of the forward-looking long-run risks (LRR) model and highlight model differences with the backward-looking habit based asset pricing model. We feature three key results: (i) Consistent with the LRR model, there is considerable evidence in the data of time-varying expected consumption growth and volatility, (ii) The LRR model matches the key asset markets data features, (iii) In the data and in the LRR model accordingly, past consumption growth does not predict future asset prices, whereas lagged consumption in the habit model forecasts future price-dividend ratios with an R2 of over 40%. Overall, our evidence implies that the LRR model provides a coherent framework to analyze and interpret asset prices.
    11/2009;
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    ABSTRACT: We put forward an equilibrium model that provides a link between the cross section of expected returns and book-to-market characteristics. We model two primitive assets: value assets, and growth assets that are options on assets in place. The cost of option exercise, which is endogenously determined in equilibrium, is highly procyclical and acts as a hedge against risks in assets in place. Consequently, growth options are less risky than value assets, and the model features a value premium. Our model incorporates long-run risks in aggregate consumption (as in Bansal and Yaron (2004)) and replicates the empirical failure of the conditional CAPM prediction. We calibrate the model and show that it is able to quantitatively account for the observed pattern in mean returns on book-to-market sorted portfolios, the magnitude of the CAPM-alphas, and other silent features of the cross-sectional data.
    09/2009;
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    ABSTRACT: We argue that the cointegrating relation between dividends and consumption, a measure of long-run consumption risks, is a key determinant of risk premia at all investment horizons. As the investment horizon increases, transitory risks disappear, and the asset's beta is dominated by long-run consumption risks. We show that the return betas, derived from the cointegration-based VAR (EC-VAR) model, successfully account for the cross-sectional variation in equity returns at both short and long horizons; however, this is not the case when the cointegrating restriction is ignored. Our evidence highlights the importance of cointegration-based long-run consumption risks for financial markets. The Author 2007. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org., Oxford University Press.
    Review of Financial Studies 02/2009; 22(3):1343-1375. · 4.75 Impact Factor
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    Hengjie Ai, Dana Kiku
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    ABSTRACT: We put forward an equilibrium model that links the cross-sectional variation in expected equity returns to firms' life cycle dynamics. The model features two sources of risks: short and long-run fluctuations in aggregate consumption, as in Bansal and Yaron (2004). Growth assets in the model are options on assets in place (i.e., value assets). The cost of option exercise, endogenously determined in equilibrium, is highly sensitive to long-run consumption risks. This provides a hedge against risks in assets in place, making growth options less risky and generating the value premium. The model is also able to endogenize the size premium: small firms in the model are highly exposed to low-frequency consumption risks as they are more likely to fail in bad times; hence, in equilibrium, small firms carry a high risk premium. In the model, the null hypothesis of the conditional CAPM/CCAPM fails: the value and size effects persist even after controlling for market risk or exposure to contemporaneous consumption innovations. We calibrate the model and show that it is able to account for the observed patterns in mean returns on book-to-market and size sorted portfolios, as well as the failure of the CAPM/CCAPM in the data.
    Journal of Financial Economics 01/2009; · 3.72 Impact Factor
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    Hengjie Ai, Dana Kiku
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    ABSTRACT: We put forward an equilibrium model that links the cross-sectional variation in expected equity returns to …rms'life cycle dynamics. In the model, assets have di¤erent exposure to short-run and long-run consumption risks (Bansal and Yaron (2004)). An econometrician who uses the conditional CAPM regression to predict asset returns will obtain high 0 s for assets that are highly exposed to low-frequency risks. Growth options have lower exposure to long-run risks than value assets because cost of exercising the growth options is highly sensitive to persistent uctuations in aggregate consumption and, therefore, provides a hedge against risks of assets in place. Small …rms exhibit high exposure to long-run risks as they are more likely to fail in bad times and, hence, in equilibrium carry a high risk premium. We calibrate the model and show that it is able to account for the observed pattern in mean returns on size and book-to-market sorted portfolios, as well as the failure of the CAPM in the data.
    12/2008;
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    Ravi Bansal, Dana Kiku
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    ABSTRACT: We show that economic restrictions of cointegration between asset cash flows and aggregate consumption have important implications for return dynamics and optimal portfolio rules, particularly for long investment horizons. When cash flows and consumption share a common stochastic trend (i.e., are cointegrated), temporary deviations between their levels forecast long-horizon dividend growth rates and returns and, consequently, alter the profile, by investment horizon, of variances and covariances of asset returns. We show that the optimal asset allocation based on the cointegration-based EC-VAR specification can be quite different relative to a traditional VAR that ignores the error-correction dynamics. Unlike the EC-VAR, the commonly used VAR approach to model expected returns focuses on the short-run forecasts and can considerably miss on long-horizon return dynamics and, hence, the optimal portfolio mix in the presence of cointegration. We develop and implement methods to account for parameter uncertainty in the EC-VAR setup and highlight the importance of the error-correction channel for optimal portfolio decisions at various investment horizons.
    Journal of Business and Economic Statistics 02/2008; 29(1):161-173. · 1.93 Impact Factor
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    Ravi Bansal, Dana Kiku, Amir Yaron
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    ABSTRACT: Asset return and cash flow predictability is of considerable interest in financial economics. In this note, we show that the magnitude of this predictability in the data is quite small and is consistent with the implications of the long-run risks model.
    12/2007;
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    Dana Kiku
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    ABSTRACT: This paper provides an economic explanation of the value premium, differences in price/dividend ratios of value and growth assets and variance-covariance structure of their realized returns within the long-run risks model of Bansal and Yaron (2004). Consistent with time-series properties of observed cash-flow data, value firms exhibit higher exposure to low-frequency fluctuations in aggregate consumption than growth firms do. This is the key input that allows the model to justify the magnitude of the historical value premium. Furthermore, heterogeneity in systematic risks across firms helps account for the violation of the CAPM and C-CAPM, resolving the puzzle.
    10/2006;
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    ABSTRACT: We argue that investor concerns about the exposure of asset returns to permanent movements in consumption levels are a key determinant of the risk and return relation in asset markets. We show that as the investment horizon increases, (i) the return's systematic risk exposure (consumption beta) almost converges to the long-run relation between dividends and consumption, (ii) return volatility is increasingly dominated by dividend shocks. We find that most of the differences in risk premia, at both short and long horizons, is due to the heterogeneity in the exposure to permanent risks in consumption. The long-run cross-sectional relation between risk and return provides a measure of the compensation for permanent risks in consumption. We find that the market compensation for these risks is large relative to that for transitory movements in consumption.
    SSRN Electronic Journal 03/2005;